Directional Movement Index (DMI)

Directional Movement Index (DMI)

The Momentum Technical Indicator measures the amount that a commodities price has changed over a given time span.

DMI displays the result as an upward directional index (+DI) and a downward directional index (-DI). The DMI also calculates the strength of the upward or downward movement and displays the result as a trend strength line called Average Directional Index or ADX.

There are basically two ways to use the Momentum indicator:

You can use the Momentum indicator as a trend-following oscillator similar to the Moving Average Convergence/Divergence (MACD). Buy when the indicator bottoms and turns up and sell when the indicator peaks and turns down. You may want to plot a short-term moving average of the indicator to determine when it is bottoming or peaking.

If the Momentum indicator reaches extremely high or low values (relative to its historical values), you should assume a continuation of the current trend. For example, if the Momentum indicator reaches extremely high values and then turns down, you should assume prices will probably go still higher. In either case, only trade after prices confirm the signal generated by the indicator (e.g., if prices peak and turn down, wait for prices to begin to fall before selling).

You can also use the Momentum indicator as a leading indicator. This method assumes that market tops are typically identified by a rapid price increase (when everyone expects prices to go higher) and that market bottoms typically end with rapid price declines (when everyone wants to get out). This is often the case, but it is also a broad generalization.

As a market peaks, the Momentum indicator will climb sharply and then fall off - diverging from the continued upward or sideways movement of the price. Similarly, at a market bottom, Momentum will drop sharply and then begin to climb well ahead of prices. Both of these situations result in divergences between the indicator and prices.

Calculation

Description: There are several variations of the momentum indicator, but whichever version is used, the momentum (M) is a comparison of the current closing price (CP) and a specific length of the previous closing prices (CPn).

Calculation:

M = CP - CPn
Or
M = (CP / CPn) * 100

The version shown in the example chart is the second version shown above, where the momentum value is the most recent closing price as a percentage of the previous closing price.

Trading Use

The momentum indicator identifies when the price is moving upwards or downwards, and also by how much the price is moving upwards or downwards. When the momentum indicator is above 0 (zero), the price has upwards momentum, and when the momentum indicator is below 0 (zero) the price has downwards momentum. The momentum indicator can be used on its own, or as part of a larger trading system.

Directional Momentum Indicator (DMI). The ADX shows the strength or weakness of the current trend and can offer signals when the trend is weakening as we approach supply or demand zones. The ADX is made up of three parts. First is the positive directional indicator or +DI. This measures the strength of the bullish pressure in price. Secondly is the negative directional indicator or –DI. As you would guess, this line measures bearish pressure in the price movement. The ADX is a summary of these two opposing forces and measures the strength of the overall trend.

A simple buy signal with the ADX would be the +DI crossing above the –DI, while a sell would be indicated when the -DI crosses above the positive. There is one major problem with waiting for this particular signal…it is always going to occur after price has moved away from supply or demand.